Transcript Keynes on Individual Behaviour and the Possibility of

Keynes on Individual Behaviour and the
Possibility of Involuntary Unemployment
Equilibrium
Roy J. Rotheim
Skidmore College
Keynes Seminar
Robinson College
15 March 2011
“This book … has evolved into what is
primarily a study of the forces which
determine changes in the scale of output and
employment as a whole…. A monetary
economy, we shall find, is essentially one in
which changing views about the future are
capable of influencing the quantity of employment
and not merely its direction” (JMK, 1936, p. vii,
italics RJR).
“Choice … presupposes that the world
is open and actual events need not have
been” (Lawson, 1997, p. 30).
Conventional Wisdom on
Unemployment
• Direction of Employment
• Quantity of Employment
Structural (Mismatch)
Unemployment
This mess was caused by over-investment in
housing, and bringing down unemployment will
be a gradual process. You can’t change the
carpenter into a nurse easily, and you can’t
change the mortgage broker into a computer
expert in a manufacturing plant very easily.
Eventually that stuff will sort itself out. People
will be retrained and they’ll find jobs in other
industries (Charles Plosser, President Federal
Reserve Bank of Philadelphia, interview in the
Wall Street Journal, Feb 14, 2011).
Revival of the Beveridge Curve
(job vacancies relative to the
number of unemployed workers)
“My dear Beveridge,
I am grateful to you for sending me your
criticism of my book….[T]he general nature
of your points is such as to convince me that I
have really had a total failure in my attempt
to convey to you what I am driving at.”
Keynesian (sic) Unemployment:
Sticky Wages in the Labour
Market [Expressed in terms of a
Hicksian ISLM or AD/AS
Framework]
“Keynesians do not think that the typical
level of unemployment is ideal—partly
because unemployment is subject to the
caprice of aggregate demand, and partly
because they believe that prices adjust only
gradually. In fact, Keynesians typically see
unemployment as both too high on average
and too variable, although they know that
rigorous theoretical justification for these
positions is hard to come by” (Alan Blinder,
1993).
Theoretical justification for both of these
interpretations is some variant of a DSGE model
(LR):the future is conflated to the present by
assuming that probability distributions of future
earnings are known and where there are
contingency contracts in all markets;
(SR): frictions in those markets may cause
temporary disequilibria.
Policy
Structural (“direction of employment”)
• Better
information,
subsidized
retraining and relocation, etc., for the
individual to make free labour supply
decisions.
• No monetary or fiscal policies
(these are individual issues)
Keynesian (“level of employment”)
• Monetary and Fiscal Policies (but only
because markets get clogged)
• these are still issues understood at the
individual level; at least the language of
the labour market is the same as the
language of the individual in a labour
market.
It’s all about individual choice,
disequilibrium and distribution
and within a or the labour market.
Each individual worker chooses to
offer her labour services at a real-wage
equal to the rate at which she is willing to
substitute work for leisure and be no
worse off
Each individual producer chooses to
hire labour at a real-wage equal to the
value of that worker’s marginal product.
Full Employment: all potential workers
will be employed (in either scenario) so
long as the wage at which they are willing
to offer labour services is equal to the
value of their marginal product
Disequilibrium and Distribution
Real Wages must fall to make labour
cheaper so that firms will be more prone
to demanding their labour services
Recessions are periods when households
dislike working…. when households
reduce their labor supply to drive up
wages” (Robert Shimer, 2009, p. 281).
Keynes found all of those explanations for
unemployment illogical, especially the
second, where he said (Ch. 19) that they
had no method of analysis by which to
conceptualise the problem
How, then, could they speak about a
redistribution of income away from labour
and toward capital as a panacea for
changes in the level of employment when
the logic of their analysis presumed that
the level of employment for the economy
as a whole could not change?
One could only posit the demand curve
for an individual firm if it were assumed
that it knew with certainty that
everything it produced would be sold at a
known price
Then one could say that labour would be
hired so long as the value of its marginal
product (the extra output sold by
employing the worker at a known price
of that product equals) equals its wage.
JMK to DHR (1933) in re ACP T of U:
“What’s in the denominator of ACP’s realwage?”
How does one go from the individual firm
(where its own, known, product price is
in the denominator of the real-wage) to
industry as a whole (where presumably
some index of wage-good prices is in the
denominator)?
It must be assumed that changes in
money-wages do not affect the price index
of wage goods (which can only occur if
output and employment for the economy
as a whole cannot change – presumes full
employment):
Closure
Hidden Implication
No individual firm’s actions (proposing to
changes wages, output, prices) can affect
the material conditions experienced by
any other firm or the outcomes of those
firm’s decisions:
Atomism
The presumption of Closure and
Atomism implies that there are no real
choices available to firms.
Presuming full employment at the outset
implies that each firm is locked in to its
optimal input mix and each worker who
wishes to work will have a job
If full employment of resources is
presumed, i.e., that the level of
employment is given and cannot change,
then how does one speak of changes in
the level of employment?
“They have no method of analysis by which
to address the problem” (Keynes, ch. 19).
There is no meaning to the idea of
disequilibrium, especially in a market that
does not exist logically
“… [T]he mathematization of economics … formalized the
system as a series of markets each described by a demand function
and a supply function. If the equations are static, they admit of
only one solution, if the equations are well behaved. There is no
other set of value for which the specified system is internally
consistent. Therefore the solution set is the equilibrium, and that
equilibrium ensures co-ordination of plans which represent
optimal choices, but there can be no meaning to disequilibrium in
such a system. The conflict between this concept and Keynes’s
conception is a major source of the difficulty in understanding
Keynes today. It is the source of statements that unemployment
equilibrium is an impossibility or an illogicality and that, rather,
the General Theory should be interpreted as a theory of
unemployment disequilibrium, possibly adding the idea that
adjustment to equilibrium is quite slow…” (Chick, 1998, 40-41).
Transcend the conceptualisation of an
individual not being willing to work at a
wage that would equal the value of her
marginal product
Transcend the idea of free choice when
there were no free choices to be had – the
consequences of the presumption of
closure
Transcend the conceptualisation of a
labour market – both a and the labour
market
Involuntary Unemployment
Equilibrium
“Men are involuntarily unemployed if, in the event
of a small rise in the price of wage-goods relatively
to the money-wage, both the aggregate supply of
labour willing to work for the current money-wage
and the aggregate demand for it at that [money]
wage would be greater than the existing volume of
employment” (1936, p.15).
“For the mere existence of an
insufficiency of effective demand may, and
often will, bring the increase of
employment to a standstill before a level of
full employment has been reached. The
insufficiency of effective demand will
inhibit the process of production in spite
of the fact that the marginal product of
labour still exceeds in value the marginal
disutility of employment” (1936, p. 31,
bold RJR).
“In a monetary production economy …
labour cannot insist on being employed,
even if its marginal revenue product and
real wage exceed the marginal disutility
of that amount of employment” (Hayes
2006, p. 47; paraphrasing 1936, p. 291).
Deconstruct those ideas
I do not choose to hire labor even if what
I make currently by employing a worker is
equal to what I pay them.
How do I know whether employing
another worker will bring in enough
revenue to cover her wage, if I were to
repeat the experiment?
The assumptions of atomism and closure
imply that the firm will always be assured
that the marginal value product of labour
equals its wage
One, then, can only make sense of
Keynes’s intuition about the possibility of
involuntary unemployment if the
assumptions of closure and atomism are
abandoned
Individuals, instead, must be socially
constructed and recognise that they are
socially constructed – their nature and
understanding of their nature exists as a
consequence of their actions in the
context of others’ actions
“Now if the term social is to designate
anything specific here, it must be a
dependency on human intentional agency”
(Lawson, 1997, p. 31)
I cannot know with any degree of
certainty whether employing another
worker will bring in enough revenue to
cover her wage, if I were to repeat the
experiment.
If events (the receipt of revenues today from
hiring so many workers) are the outcomes of
systems that are open (in the sense that each
individual’s actions affect and are affected
materially by others’ actions – “intrinsic
closure” is violated), then it is impossible for
any firm to be assured that the outcome they
just experienced will repeat itself if they
engage labour in exactly the same way as they
just did.
Current income, transcending atomism
and closure, is not a reliable indicator of
what the future will bring if I were to
repeat my production plans -- a
concurrence of events does not (cannot)
assure a constant conjunction of events
“Choice … presupposes that the world
is open and actual events need not have
been” (Lawson, 1997, p. 30).
Keynes makes intentional, purposeful
choice, by a socially constructed
individual, to stand at the focal point of
his analysis.
Just because something occurred, does
not mean that it will recur, even if I do
everything exactly the same 
expectation of what might occur if I
were to do everything the same, but in
an open system’s framework where I
had better be thinking about what
others might be doing as well and how
their actions might affect my
outcomes.
“This book … has evolved into what is
primarily a study of the forces which
determine changes in the scale of output and
employment as a whole…. A monetary
economy, we shall find, is essentially one in
which changing views about the future
are capable of influencing the quantity of
employment and not merely its direction” (JMK,
1936, p. vii, bold and italics RJR).
[O]ur method of analysing the
economic behaviour of the present
under the influence of changing ideas
about the future…” (Keynes, 1936)
Keynes called the method for analysing the
economic behaviour of the present under
the influence of changing ideas about the
future his Theory of Effective Demand
“I am not interested in constructing a
building, so much as in having a
perspicuous view of the foundations of
possible buildings. So I am not aiming at
the same target as the scientists and my
way of thinking is different from theirs”
(Ludwig Wittgenstein, Culture & Values
p.7, quoted in Monk 300- 301)
The object of our analysis is, not to provide a
machine, or method of blind manipulation,
which will furnish an infallible answer, but to
provide ourselves with an organised and
orderly method of thinking out particular
problems…” (Keynes, 1936, p. 297).
The point of Effective Demand, according
to Keynes, occurred where the aggregate
supply price of a given level of
employment equaled the aggregate
demand price of that level of employment
The language of this theory is predicated
on our socially contextual individual who
must think in terms of the expectation of
receipts by engaging any level of
employment
“The aggregate supply price of the output
of a given amount of employment is the
expectation of proceeds which will just
make it worth the while of the
entrepreneurs to give that employment”
(1936, p. 24)
He defines Aggregate Demand “to be
the proceeds which entrepreneurs
expect to receive from the employment
of N men…” (1936, p. 25).
How much revenue a firm expects to
receive will be a function of many
factors, some which are in its control,
some which are beyond its control
because it recognises that it is not the
safe atom operating within the closed
framework presupposed by the
mainstream
How much employment each producer
engages is based on the expectation of
revenue in this open environment,
which takes on different forms
depending upon the time-frame in
which it is engaging that labour.
In the immediate or short-period (see
Hayes for some interesting insights in
the notion of periods in Keynes) Keynes
reckons that it might “be sensible for
producers to base their [short-term]
expectations on the assumption that the
most recently realised results will
continue, except in so far as there are
definite reasons for expecting a change”
(p. 51).
“Nevertheless, we must not forget that, in the
case of durable goods, the producer’s shortterm expectations are based on the current
long-term expectations of the investor; and it is
of the nature of long-term expectations that
they cannot be checked at short intervals in the
light of realized results…. Thus the factor of
current long-term expectations cannot be even
approximately eliminated or replaced by
realised results” (1936, p. 51).
“[I]n the case of additions to capital
equipment and even of sales to distributors,
these short-term expectations will largely
depend on the long-term (or mediumterm) expectations of other parties. It is
upon these various expectations that the amount
of employment which the firms offer will depend
(1936, p. 47, italics RJR)
Marginal Efficiency of Capital
“…I define the marginal efficiency of
capital as being equal to that rate of
discount which would make the
present value of the series of annuities
given by the returns expected from the
capital-asset during its life just equal
to its supply price” (1936, p. 135,
italics RJR).
Keynes reckoned that the MEC would
(or should it have been ‘could’?) fall as
more producers increased their
investment activities because:
• The cost of producing more capital
goods would rise;
• The price of the extra output would
fall as more was brought onto the
market.
The individual firm would have no
way of knowing with certainty what
would happen to the replacement
cost of her capital as she purchased
more of it or whether she could sell
all the extra output produced by the
extra capital and at what price it
might sell.
It is for this reason that Keynes
thought of the MEC in terms of the
prospective yield on a capital asset; it
is within an open system that Keynes
is identifying the basis upon which
individuals can know.
Traditional theory (including modern
DSGE models) assumes complete
markets (closure) and atomism, so that
their investing firm need worry only
about their production function and
whatever is the marginal product of
capital – something internal to the firm;
not dependent on what other firms
might do.
“The ordinary theory of distribution,
where it is assumed that capital is getting
now its marginal productivity (in some
sense or other), is only valid in a
stationary state. The aggregate current
return to capital has no direct
relationship to its marginal efficiency”
(1936, p. 139).
“The most important confusion
concerning the meaning and
significance of the marginal
efficiency of capital has ensued on
the failure to see that it depends on
the prospective yield of capital, and
not merely on its current yield”
(1936, p. 141).
“[I]n the case of additions to capital
equipment and even of sales to distributors,
these short-term expectations will largely
depend on the long-term (or mediumterm) expectations of other parties. It is
upon these various expectations that the amount
of employment which the firms offer will depend
(1936, p. 47, italics RJR)
Involuntary Unemployment Equilibrium
“For the mere existence of an
insufficiency of effective demand may, and
often will, bring the increase of
employment to a standstill before a level of
full employment has been reached. The
insufficiency of effective demand will
inhibit the process of production in spite
of the fact that the marginal product of
labour still exceeds in value the marginal
disutility of employment” (1936, p. 31,
italics RJR).
The Keynesian Revolution: Opened and
Closed in an Instant
J.R. Hicks
“Mr Keynes and the Classics: A Suggested
Interpretation” Econometrica, April 1937
“My dear Hicks,
At long last I have caught up with my reading and have been
through the enclosed. I found it very interesting and really have next to
nothing to say by way of criticism.
…At one time I tried the equations, as you have done, with I in all of
them. The objection to this is that it overemphasizes current income. In
the case of the inducement to invest, expected income for the period of
the investment is the relevant variable. This I have attempted to take
account of in the definition of the marginal efficiency of capital. As soon
as the prospective yields have been determined, account has been
implicitly taken of income, actual and expected. But, whilst it may be
true that entrepreneurs are over-influenced by present income, far too
much stress is laid on this psychological influence, if present income is
brought into such prominence. It is, of course, all a matter of degree.
My own feeling is that present income has a predominant effect in
determining liquidity preference and saving which it does not possess in
its influence over the inducement to invest” (JMK to JRH, 31 March
1937, in CW XIV, pp. 79-80).
“Your other points I agree with mostly; except that I
remain impenitent about including income in the
marginal efficiency of capital equation. Of course I
agree that it is expected income that logically matters;
but the influence of current events on expectations
(admittedly a loose and unreliable connection) seems to
me potentially so important, that I feel much happier if
it is put in and marked unreliable, than it if is merely
talked about, and not impressed on the reader’s mind by
being put into the formula, which he will take down in
his notes” (JRH to JMK, 9 April 1937, in CW XIV, pp.
81-82).
Roy Harrod
“Mr Keynes and Traditional Theory,”
Econometrica, January 1937
“My dear Roy,
I like your paper…more than I can say. I have
found it instructive and illuminating, and I really have
no criticisms. I think that you have re-oriented the
argument beautifully. I also agree with your hints at the
end about future dynamic theory.
I am reading a paper to the economic club at
Stockholm on about the same date as you will be
reading this, and have been thinking (it isn’t written
yet) of trying to pick out what I thought most
important. But I now feel that I should like to read
them your paper instead!” (JMK to RFH, 30 August,
1936, in CW XIV, pp. 83-84).
“There are, however, one or two points
mainly omitted in yours which I should
be inclined to put into mine: -… 2. You don’t mention effective
demand or, more precisely, the demand
schedule for output as a whole, except in
so far as it is implicit in the multiplier…”
Concluding Remarks
On the Impossibility of Involuntary
Unemployment Equilibrium in Mainstream
Economic Theory or Policy